Ottawa to rein in income 'sprinkling' by wealthy Canadians

Ottawa wants to recoup at least $250-million a year from high-income Canadians who use private corporations to reduce their tax bills, unveiling measures to prevent professionals from "sprinkling" income to family members in lower tax brackets.

The federal government also wants to close loopholes not available to salaried workers by changing the way it taxes private corporations in relation to capital gains and "passive" income. The measures unveiled Tuesday will not be immediately enacted, but the government is launching consultations in the lead-up to final proposals in coming months.

There has been an explosion in the number of private corporations in Canada in recent years, with many non-salaried individuals capitalizing on the growing spread between top income-tax rates and small business rates, which now stands at a 37 point difference.

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The government hopes to recoup at least $250-million a year with the proposed changes, estimating 50,000 families are using income "sprinkling" to reduce their overall tax bills. In one example provided by Finance officials, an individual making $220,000 a year could reduce his or her tax bill by $35,000 by redistributing about $100,000 to family members, such as children or a spouse in lower tax brackets.

About 300,000 corporations would also be affected by the changes to the treatment of passive income, which refers to investments such as stocks and real estate. In addition, the proposed measures would harmonize the treatment of "passive" investment portfolios and limit the ability to convert a private corporation's regular income into capital gains, which benefit from a more favourable tax rate.

Finance Minister Bill Morneau said the changes are necessary to "level the playing field" among taxpayers. Mr. Morneau, who said the changes would likely increase his own tax bill, said he wants to prevent taxpayers from benefiting from "fancy accounting schemes."

"What we're trying to do is ensure that people who are getting their income through a typical salary … are not in a situation that is worse off than someone who might be able to use a private corporation to sprinkle income among family members or to turn regular income into capital gains," he said at a news conference.

Kevin Milligan, a professor at the Vancouver School of Economics at the University of British Columbia, said the new rules largely erase any advantage professionals gain from using a private corporation. "If you were sitting down with a tax planner who is listing the reasons why you want to do it this way instead of the regular way, a lot of those things have now been crossed off the list," he said.

Opposition parties and lobby groups are worried legitimate business owners would be the ones bearing the brunt of the new measures.

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"We agree with the principle that income, whether it's personal or business, should be treated in a similar fashion," said Dan Kelly, president of the Canadian Federation of Independent Business. "At this stage, we do worry [these measures] could catch a lot of family businesses by surprise and change fairly broadly the way a lot of small businesses organize themselves for tax purposes."

Mr. Morneau said the changes are not targeted at legitimate businesses, which are supposed to be the ones benefiting from lower corporate tax rates. "We're closing down loopholes that people are using at an increasing pace to give themselves a lower tax rate," he said. "This will not impact active businesses making investments in their businesses."

Conservative finance critic Gérard Deltell said his party would participate in the government's consultations on the tax changes. "We agree with the process," he said. "However, we will be extremely vigilant to ensure that we don't end up punishing those who create real jobs and wealth."

The NDP accused the government of dragging its feet on the issue of tax evasion and tax avoidance.

"The Liberals love to consult," NDP House Leader Murray Rankin said, "but this issue has been well studied and we could act right away."